Has Blockbuster Left Netflix Standing Alone?

No one is happier than Netflix (Nasdaq: NFLX) to hear that Blockbuster (NYSE: BBI) is tired of running a money-losing online business.

Shares of Netflix rose nearly 10% yesterday after Blockbuster told some of its Total Access subscribers about upcoming price hikes.

New users will now pay $19.99 a month -- up from $17.99 a month -- for the most popular plan, which allows members unlimited DVD rentals by mail, as long as they have no more than three flicks out at any given time. It is similar to the Netflix $16.99 monthly plan, with Blockbuster adding value by providing up to five free in-store exchanges during the month.

The high-end Blockbuster plan that allows for unlimited in-store exchanges will go up a whopping $10 to $34.99. Yikes. You'll really have to love celluloid to stick around on that one.

Taking a barbell approach, Blockbuster is lowering its cheapest plan -- which provides no in-store exchanges and is limited to just one DVD out at any given time -- to $3.99 a month from $4.99.

The kicker here is that only some of its existing subscribers will be subjected to the higher rates.

In other words, the more active users for Total Access will not be grandfathered into the older, cheaper rates.

Man. You thought Netflix was bad when it would throttle users by sending limited copies of new releases to its most profitable users first? Now Blockbuster is raising the stakes by installing weighing stations.

"This is not a plan to drive people away," she said. "We want to keep them all."

Riiiight. And I'm going to raise prices at my kissing booth to make the lines even longer.

Turning things aroundBlockbuster isn't stupid. It knows exactly what it's doing. When it first raised prices over the summer, the company closed out the quarter with 500,000 fewer subscribers. Yesterday, it birthed a scapegoat. Now when it posts yet another quarter-to-quarter decline for the holiday quarter, it can simply shrug its shoulders and point to the hike.

It's a genius plan. Then again, even if I'm wrong about the scapegoat incubator, it's still the right thing to do. The unlimited in-store exchanges have basically laid out the welcome mat for unscrupulous hyper-renters who burn rentals to DVD and rush them back to Blockbuster. By practically forcing them to downgrade to the $19.99 plan, Blockbuster is able to cap frenetic in-store habits.

The $3.99 plan on the low end is brilliant, too. Since they're not getting any in-store freebies, the mailers can be used to promote in-store purchases.

That has always been the key of the in-store exchanges with Total Access. It doesn't need to turn a profit on its mail-order business if that is more than offset by increased in-store sales volume. Obviously, that isn't happening.

CEO Jim Keyes was supposed to come in and shape up the Blockbuster retail experience after mastering the turnaround at 7-Eleven. It may still happen, but this isn't an overnight transformation.

Keyes is testing several models to enhance the physical storefront experience. In speaking to the Fool's Anders Bylund last month, Keyes dreamed of channeling companies like Starbucks (Nasdaq: SBUX) , to drum up a hipster coffee-bar vibe -- or RadioShack (NYSE: RSH) , to offer kiosks where consumers could download rentals onto their laptops or Apple (Nasdaq: AAPL) iPods and snap up related accessories.

The problem is that we're not there yet, and time isn't on Blockbuster's side. Keeping Total Access subscribers close and happy means losing more money. In making the sensible pricing adjustments now, it risks alienating its user base.

Make it a Blockbuster frightThe real question is whether DVD rentals by mail is a market worth saving. Until proven otherwise, it appears the market peaked at the end of the second quarter with a combined 10.4 million subscribers between Netflix and Blockbuster. That was when Blockbuster had more net additions than the net defections at Netflix. The tables turned in the following quarter, with Netflix growing its member count, but only at half the rate of the defections at Blockbuster. The companies combined to watch over just 10.1 million film buffs as of the end of September.

Both companies have fledgling Web-based content delivery plays in place, but that's going to be a cutthroat market in the future. Netflix has the advantage of years of user ratings it can use to serve up a recommendations engine that's second to none in flick rentals, but Amazon.com (Nasdaq: AMZN) isn't exactly a slouch on that front, either.

In the near term, Netflix is going to do well. It's the profitable one. It now has flexibility to expand margins through either higher prices or reduced marketing costs. This doesn't take away from my biggest concern -- that the industry will not get back to 10.4 million subscribers (or even worse, that it will shrink below 10.1 million this quarter).

Pricing sensibility has arrived. Hooray. Now where are the people?

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Longtime Fool contributor Rick Munarriz has been a Netflix subscriber -- and shareholder -- since 2002. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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